Towards the end of the week, I caught a Tweet which said that the latest French bond auction was the most expensive since President Hollande came to power. On its own, this little titbit of information seemed innocuous enough, but it struck a chord with me. It’s been a while since I did a cycle through the collection of charts I have to help me gauge the temperament of this QE-fuelled market. It was high time I got my head back in the game.
To be perfectly honest, with the taper around the corner, I’ve actually done very little on the main indices since I closed my short on the Dow a few weeks ago. Apart from the long list of reasons to stay out of the market at present (e.g. uncertainty over the war in Syria, crucial US monetary and fiscal events, the German election, Japanese economic reforms, general rout of the BRICS and so on…), I’ve also wanted to reflect on how to position myself once the FOMC decides to act. Naturally the devil is going to be in the detail of whatever they announce, but I’ve increasingly questioned my original view that the taper is going to represent an immediate sea change in the outlook for US stocks.
Nevertheless, there is still a widespread and rising sense of unease out there; evidenced by the charts I use. What remains to be seen, however, is how strong this unease is.
Ask many people and they will tell you the most obvious manifestation of market fear has been the increase in the price of gold. We all know about the fantastic sprint the precious metal has been on recently and, in spite of running into technical resistance, the strength of the move looks set to continue. However, the reasons behind this might not be what many expect. With so many potential headwinds facing the global economy, there is a compelling logic that gold’s rally is an anxious reaction to pending events. Yet I wonder, in fact, if this is actually being driven by more fundamental influences, but, as much as I’d love to go into these now, this is not why I write today.
So back to my charts!
Below is the 5 year chart of the S&P 500 Volatility Index (the VIX);
On Friday the VIX closed at 15.85. Although this is well below the crisis levels often witnessed since 2008, the recent upturn has been sharp. The VIX is something of a trailing indicator (i.e. it is not that useful at helping traders position themselves ahead of many major market moves), but it is widely followed and reported on. If it moves higher from here, through the 20 mark, then the chances of a large sell-off occurring are likely to increase. That is, of course, if it is not already well under way…
Equally though, if the VIX falls, the market could resume its march higher.
Next come the St Louis Fed Financial Stress Index (STLFSI),
Found here, the STLFSI is an excellent indicator of the health of the financial system. Given how the health of the financial system has come to dominate the direction of markets, this is a chart I often refer to. Currently it reads -0.418 and has risen for three consecutive weeks. While this is also below crisis levels, it is worth keeping an eye on what happens to this index in the next few weeks, in advance of the next FOMC meeting, in ten days’ time.
Finally, I examined the 10 year charts of yields on selected 10 year Government bonds;
The rise in yields has been well documented. Irrespective of this, it looks highly significant that Japanese yields have started to fall again, with the Bank of Japan pressing full steam ahead with its QE programme and this is a theme I plan to return to in future blogs. However, what interests me now about American and European yields is that though they have clearly been going up, taking a 10 year view of prices, this move simply looks like the market is normalising. This is a vastly different proposition to much of the hyperbolic coverage about the change in the bond market. After all, we have just been through a period of historically low yields and it is far from certain they will continue to rise, once the FOMC finally announces its taper.
Overall, I could understand why someone viewing the charts above could feel deeply pessimistic about the imminent prospects for the market. However, that isn’t my interpretation. The uptick in fear is clear, yet it falls far short of what has been experienced over the last 5 years. A further deterioration in some or all of the indicators above could, naturally, spell trouble, but while the actual numbers remain well below crisis levels, any taper related pullback should present an excellent buying opportunity. I still plan to digest what happens over the next week, before getting back into the market. When I do, though, I expect to buy.